False Dilemma

Harvard Business School Professor Michael Porter argued back in 1985 that there are three generic strategies that an organisation can follow to achieve above average performance.

You can operate at low cost, provide distinct value to customers, or focus on doing one of these things while targeting a specific niche in the market.

The unfortunate fallacy that Porter introduced is that he made us think of these three choices, “low cost”, “differentiation” and “focus”, as three separate strategy alternatives.

In reality, they might more accurately be thought of as three necessary ingredients of any strategy that stands a chance of thriving in the long run.

Two companies that appear to have adopted the strategy trifecta are Aldi and Ikea.

Both firms have focused on a particular market niche. Ikea provides nicely designed furniture, and Aldi provides good quality groceries.

Both firms have designed their organisations to enable them to operate at low cost and they have passed these savings on to the customer.

The additional beauty of pursuing this strategy is that delighted customers can’t help but talk about the value for money that they receive, and so the firms make further savings by being able to reduce their marketing costs.

The choice of pursuing low cost or high value is a false dilemma.

While it is true that it might be difficult to achieve both on any given day if the resources and systems are not in place, it is also true that organisations don’t exist merely at a point in time.

Most organisations exist for many years and a sound strategy is one that will make this enduring existence more certain, sustained and successful.

The Connection Economy

Connection Economy

(Source: Flickr)

Traditional strategic thinking, the kind championed by HBS Prof Mikey Porter, says that real economic value is only created when a company can sell a product or service to customers at a price that exceeds the cost of producing it.

In other words, companies are entities that sell products or services, and strategic thinking is all about figuring out how to do this profitably. End of story.

This view seems to make sense, and in a world before the Internet it definitely made a lot of sense.

The problem though is that business on the Internet is not primarily about selling products and services.

The Internet allows people to connect with each other at pretty much zero cost, and successful Internet-based companies like LinkedIn, Facebook and eBay have accepted this reality.

By building business models that enable people to connect around a common interest or shared purpose in a way that can be scaled these Internet-based companies have produced significant economic value in a way that is often sustained not by the sale of products or services but through advertising, commissions, memberships and distribution fees.

The Internet enables connection, and an economy where people produce economic value by building markets and communities.

For tech founders monetisation is often a second-order problem, and while part of the solution may involve selling products and services, this will not always and not necessarily be the case.

Part of good strategic thinking involves accepting the world as you find it, and adapting your approach.

Is your business connecting with people, or helping people connect with each other?

Should it be?

Porter’s Generic Strategies

Three strategies to achieve above-average performance: cost leadership, differentiation, and focus

Porter's Generic Strategies

(Source: Flickr)

In order to understand Porter’s Generic Strategies, it is helpful to take a step back and examine the two things which determine a firm’s profitability in the long run.

The first is industry attractiveness, which is determined in any industry by the five competitive forces: the threat of entry by new competitors, the threat of substitutes, the bargaining power of buyers, the bargaining power of suppliers, and the rivalry among existing firms.

Five Forces

Figure 1: Porter’s Five Competitive Forces that Determine Industry Profitability

It is the collective strength of these five forces that determine whether firms in an industry will be able to earn attractive rates of return. In industries where the five forces are favourable, such as the soft drink industry, many competitors have earned attractive returns for many decades. However, where one or more of the forces exerts strong pressure on industry profitability, such as in the airline industry, few firms ever do well for very long.

Understanding industry structure, as determined by the five forces, will inform a firm’s decision to enter or exit an industry, and will also be a key consideration for industry leaders who have the ability to mould industry structure for better or for worse. For example, Coca-Cola is a leader in the soft drink industry and could, if it wanted to, encourage the production and sale of generic unbranded soft drinks. Even if this would increase Coca-Cola’s profits in the short run, it would also threaten the industry structure. Generic cola may increase the price sensitivity of buyers, lead to aggressive price competition, and lower barriers to entry by enabling new competitors to enter the market without a large advertising budget.

In addition to industry attractiveness, the second thing which determines a firm’s profitability in the long run (and this is where Porter’s Generic Strategies comes in) is a firm’s relative position within the industry. That is, can a firm position itself to achieve above average performance within its industry? Or put differently, is it possible for a firm to establish and maintain a competitive advantage?

In his 1985 book Competitive Advantage, Michael Porter explains that there are two basic sources of competitive advantage that a firm can possess: cost leadership and differentiation. A firm can also narrow the scope of its activities to compete in niche segments of the market, and so there are three generic strategies that a firm can adopt to achieve above-average performance: cost leadership, differentiation, and focus.

Porter's Generic Strategies

Figure 2: Three Generic Strategies

Porter’s generic strategies are based on the idea that in order to achieve a competitive advantage a firm needs to make hard choices. Trying to be all things to all people will put a firm on the fast track to mediocrity, and so a firm needs to decide what kind of competitive advantage to pursue and which market segments it should target.

Cost Leadership

As the name suggests, a firm that pursues cost leadership aims to be the low cost producer in its industry. While the strategy involves a primary focus on cost reduction, the cost leader will still need to produce comparable products in order to maintain prices. If a firm can sustain cost leadership while at the same time charging prices at or near the industry average, then this strategy can allow a firm to achieve above average performance.

One danger of the cost leadership strategy is that if there is more than one aspiring cost leader then this can lead to intense competitive rivalry and ultimately destroy industry profitability. If a firm wants to be the cost leader, then its best bet is to get in first in order to deter the competition.

Differentiation

Differentiation is a strategy in which a firm sets out to provide unique value to buyers. This may be achieved in various ways including producing products with unique features, serving buyers through new or different distribution channels, or by creating perceived differences in the buyer’s mind through clever marketing.

If a firm is able to charge a price premium that exceeds the cost of sustaining its uniqueness, then the firm will be able to achieve above average returns. While the strategy involves a primary focus on “being different” the differentiator still needs to manage costs, and will want to reduce costs in any area that does not contribute to differentiation.

Focus

The focus strategy involves narrowing the scope of competition in order to serve certain niche segments within the overall market. By serving these target segments well, the focuser may be able to achieve a competitive advantage in its niche even though it does not enjoy a competitive advantage in the market overall.

Stuck in the Middle

So there you have it, three generic strategies for achieving above average performance: cost leadership, differentiation and focus.

Be warned though, a firm that dabbles in each of these strategies while failing to successfully pursue any of them faces the risk of becoming “stuck in the middle” and being perpetually outperformed by the cost leader, the differentiators and the focusers.

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]

Giving and Growing

Business can step up by reaching out, but it needs to adopt a new approach

Shared Value

THE OLD MODEL of corporate giving involves the CEO championing a particular charity, and then writing a cheque.

The old model is broken.

Broken because it relies on the whim of the CEO, who could change her priorities at any time. And, while the generosity continues to flow, the beneficiaries of this corporate largess become dependent on hand-outs rather than learning to catch their own fish.

Broken because it fiddles shareholders, who pay the CEO to reinvest profits or pay a dividend. And, if the CEO instead uses shareholder money to champion her favourite charity, then there would seem to be a problem. Would it not make more sense to pay a dividend and allow shareholders to decide which charities to support?

Supporters of the old model will tell you that it works just fine, so long as the chosen charity prominently displays the firm’s logo on the charity’s website or at a high-profile community event.

We agree. This works. But it’s not charity. It’s advertising, it’s marketing, or it’s a PR campaign.

Call it what you will.

If you care about charity, there is a better way.

Shared Value – the new approach to charity

The new approach to charity is to tie it in with what your firm already does, and to use your existing resources and capabilities to reach out to the community (people, charities, government agencies, and existing suppliers and distributors). For example, if you run a private healthcare centre, or a pharmaceutical company, then there may be opportunities to help the growing number of people who are struggling with substance abuse problems.

The naysayers will tell you that charity is for the Church and solving social problems is a role for government (and fortunately there are already public support services for addiction), but this kind of thinking is both defeatist and short sighted.

There are three good reasons why reaching out to help the community makes good business sense:

  1. Motivation: By giving back to the community, you can create a higher purpose for the work you do and increase employee motivation;
  2. Learning By Doing: As early as the 19th century, German psychologist Hermann Ebbinghaus identified that (as you would expect) people become more efficient the more times they perform a particular task. And so, by helping the community, by doing what you do best, you are actually helping your employees learn by doing;
  3. Connections: Friendships are valuable, and you never know who you could meet by reaching out to help others.

So, take some time to consider your core values, investigate what your competition is doing, and consider your options for embracing the new model of charity.

Who do you plan to help, and why?

Why business can be good at solving social problems

By addressing social issues with sustainable business models, business leaders have the potential to provide scalable solutions

MICHAEL PORTER makes an astute observation – the world is full of social problems.

From environmental degradation and disease to unemployment and inequality, solving social problems has traditionally been the domain of NGOs, the government and philanthropists.

Meanwhile, business school professors and corporate CEO’s like Jack Welch spread the gospel that the primary goal of business is to “maximise shareholder value”.

If the relentless drive for profits happened to create social problems like pollution or obesity, then that was certainly regrettable. And the government should probably do something about that.

Traditional business thinking drew a very clear line between social problems and the world of business.

Fortunately, a new brand of business thinking has now evolved, and Professor Porter is flying the flag to raise awareness for a game changing business philosophy he calls “shared value”.

The basic idea is fairly simple; by using sustainable business models to address social issues, businesses can create social value and economic value at the same time.

As we identified back in March when we looked at Sustainable Social Enterprise, one of the core problems with traditional charities and government social programs is that the solutions don’t scale. Beholden to government budgets, political interests, or the whim of philanthropists, the very programs designed to solve our most challenging social problems remain financially constrained. Without a sustainable business engine, their wings are clipped, and many promising initiatives never even get off the ground.

The business sector has a role to play in solving social problems since they understand the power of profit.

If you provide good value for a fair price, and recoup your costs in the process, then you buy yourself the chance to do it again, and again. The virtuous cycle of value creation flows from having a sustainable business model and the resulting profits can enable a business to scale the solution.

As fate would have it, solving social problems can also make good business sense:

  • healthier employees are more productive employees,
  • a safer workplace means less downtime and fewer lawsuits,
  • reducing pollution can help a business become more efficient and productive, and
  • helping suppliers improve their capabilities can help an upstream firm to streamline or customise its own production line.

The world is full of social problems, and the opportunities to have a positive social impact are bigger than ever.

The only difference is that, this time, business can be part of the solution.

Understanding Michael Porter: The Essential Guide to Competition and Strategy


MICHAEL Porter is the thought leader in the field of business strategy.

He has single-handedly shaped the way in which the world’s top business leaders think about competitive strategy and success. And his concepts like “competitive advantage”, “value chain” and “five forces” form the bedrock for management thinking about complex business issues.

Unfortunately, his frameworks are often bastardised, misused and misunderstood.

The good news is that there now appears to be a solution to this problem.

Joan Magretta, former editor at Harvard Business Review, launched today a book called Understanding Michael Porter.

The book is said to be the first concise, accessible summary of Porter’s revolutionary thinking.  To quote the Harvard Business Review:

Magretta uses her wide business experience to translate Porter’s powerful insights into practice and to correct the most common misconceptions … that competition is about being unique, not being the best; that it is a contest over profits, not a battle between rivals; that strategy is about choosing to make some customers unhappy, not being all things to all customers.

Free book chapter

As an amazing bonus, you can read the introduction to the book for free here.

Buy the book

If interested, you can visit Amazon, read the reviews and consider buying the book: click here.

Review

As an aside, your author has not yet read the book (but intends to do so).

If you have read the book, what did you think?

Post a comment below.  We would be interested to know your thoughts.

Porter’s Six Steps of Strategic Positioning

There are six strategic principles which are relevant to any company that wants to be profitable online

Porter Six Steps

IN AN article entitled “Strategy and the Internet” published in the March 2001 edition of the Harvard Business Review, Michael Porter outlined six principles that he believes companies need to follow if they want to establish and maintain a distinctive strategic position in the market place.

Since the internet is a business platform with low barriers to entry, these six strategic principles are particularly relevant to any company that wants to be profitable online:

1. Stand for something

In order for a company to develop unique skills, build the right assets, and establish a strong reputation it is important to define what the company stands for so that the company will have continuity of direction.

2. Focus on profitability

This point seems obvious, however many internet based companies have instead focused on “unique visitors” and “page views” as measures of performance. At the end of the day, sustainable profits will only be possible where goods or services can be provided at a price which exceeds the cost of production.

3. Offer consumers a unique set of benefits

Good strategy involves being able to provide a distinct set of benefits to a particular group of consumers. Trying to please every consumer will not give a company a sustainable competitive advantage.

4. Perform core activities differently

If a company is able to establish a distinctive value chain by performing key activities differently from its competitors, then this will help the company establish a sustainable competitive advantage.

5. Specialise

There is no competitive advantage to being a jack of all trades and a master of none. Porter recommends making trade-offs.  By focusing on certain activities, services or products at the expense of others a company can establish a unique strategic position.

6. Ensure that all activities reinforce the company’s strategy

All of a company’s activities are interdependent and, as a result, they must be coordinated so as to reinforce the company’s overall strategy. A company’s product design, for example, will affect the manufacturing process and the way that products are marketed. By coordinating all of its activities, a company makes it harder for competitors to imitate its strategy.

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]

Porter’s Five Forces Analysis

The Porter’s Five Forces framework is used to determine the competitive intensity and attractiveness of an industry

Porter's Five Forces

HARVARD Business School professor Michael Porter, in his 1979 book Competitive Strategy, developed the Porter’s Five Forces.

The Porter’s Five Forces framework is used to determine the competitive intensity and attractiveness of an industry. Attractiveness in this context refers to the overall industry profitability. You can use this framework when introducing a new product, expanding into a new market, divesting a product line, acquiring a new business, or assessing the cause of declining sales or profitability.

In determining the competitive intensity of an industry, Porter’s Five Forces include three forces from ‘horizontal’ competition (1, 2 and 3), and two forces from ‘vertical’ competition (4 and 5):

  1. Existing competition: How strong is the rivalry posed by the present competition?
  2. Barriers to entry: What is the threat posed by new players entering the market?
  3. Substitutes: What is the threat posed by substitute products and services?
  4. Supplier bargaining power: How much bargaining power do suppliers have?
  5. Customer bargaining power: How much bargaining power do customers have?

Porter's Five Forces

1. Competition: How strong is the rivalry posed by the present competition?

The intensity of competition in an industry is affected by various factors, including:

  1. The number of firms in the industry, the more firms the stronger the competition because there are more firms competing for the same customers;
  2. Slow market growth leads to increased competition because there is only a small number of new customers entering the market each year, firms must compete to win existing customers;
  3. Where firms have economies of scale, that is they have relatively high fixed costs and low variable costs, the more they produce the lower their per unit costs become. This results in more intense rivalry between firms as they compete to gain market share;
  4. Where customers have low switching costs, this intensifies competition as firms compete to retain their current customers and steal customers from other firms;
  5. Low levels of product differentiation between firms leads to increased competition. Where a firm has a strong brand name or a highly differentiated product, this reduces the intensity of competition;
  6. Diversity of competition (for example, firms from different countries and cultures) reduces the predictability and stability in the market.  Uncertainty in the market leads firms to compete more agressively, thereby driving down firm profits in the industry;
  7. High exit barriers increase competition because firms that might otherwise exit the industry are forced to stay and compete. A common exit barrier is where a firm has highly specialised equipment that it cannot sell or use for any other purpose; and
  8. An industry shakeout will result in a short period of intense competition. Where a growing market induces a large number of new firms to enter the market, a point is reached where the industry becomes crowded with competitors. When the market growth rate slows and the market becomes overcrowded, a period of intense competition, price wars and company failures ensues.

2. Barriers to entry: What is the threat posed by new players entering the market?

In theory, any firm should be able to enter a market, however, in reality industries often possess characteristics that prevent new players from entering the market (barriers to entry).  Barriers to entry reduce the rate of entry of new firms, thus maintaining the level of profits for those firms already in the industry.

Barriers to entry may exist for various reasons, including:

  1. high capital costs of setting up a business in a particular industry;
  2. where an industry requires highly specialised equipment, potential entrants may be reluctant to commit to acquiring specialised assets that cannot be sold or converted into other uses if the venture fails;
  3. lack of the proprietary technology or patents that are needed to become a player in the industry;
  4. extensive scale and branding of existing competitors may prevent potential entrants from gaining market share and hence deter entry into the market;
  5. government regulations: Government may regulate to prevent new firms from entering an industry. It might do this because of the existence of a natural monopoly. A natural monopoly is an industry where one firm is able to produce the desired output at a lower social cost than could be achieved by two or more firms (social costs being the sum of private and external costs). Natural monopolies exist because of the existence of economies of scale, and examples include railways, water services, and electricity; and
  6. Individual firms may have economies of scale. The existence of such economies of scale creates a barrier to entry because an existing firm can produce at a much lower cost per unit than a new firm.

3. Substitutes: What is the threat posed by substitute products and services?

Economics defines substitute goods as goods for which an increase in demand for one leads to a fall in demand for the other. In the Porter’s Five Forces framework, a reference to a substitute good refers to a good in another industry. For example, natural gas is a substitute for petroleum.

Good A and good B are substitutes if they can be used in place of one another (at least in some circumstances). The existence of close substitutes constrains the ability of a firm to raise prices and, as the number of substitutes increase, the quantity demanded will become more and more sensitive to changes in the price level (i.e. price elasticity of demand for the product increases).

The threat posed by substitute goods is affected by various factors, including:

  1. the cost to customers of switching to a substitute product or service (switching costs). For example, the cost of switching between the Windows operating system and Apple operating system might be prohibitive because computer programs and accessories are built to work with one operating system or the other;
  2. buyer propensity to substitute;
  3. relative price-performance of substitutes; and
  4. perceived level of product differentiation.

4. Supplier bargaining power: How much bargaining power do suppliers have?

Suppliers are providers of the inputs to the industry, for example, labour and raw materials. Factors that will effect the bargaining power of a supplier include:

  1. The number of possible suppliers and the strength of competition between suppliers;
  2. Whether suppliers produce homogenous or differentiated products;
  3. The importance of sales volume to the supplier;
  4. The cost to the firm of changing suppliers (switching cost);
  5. The presence of substitute inputs; and
  6. Vertical integration of the supplier or threat to become vertically integrated. Vertical integration is the degree to which a firm owns its upstream suppliers and its downstream buyers. For example, a car manufacturer may also own a tyre manufacturer.

5. Customer bargaining power: How much bargaining power do customers have?

Customers are the purchasers of the goods or services produced by the company.  Factors that will effect the bargaining power of a customer include:

  1. The volume of goods or services purchased. If the customer purchases a significant proportion of output, then they will have a significant amount of bargaining power;
  2. The number of customers. The fewer customers there are, the more bargaining power they will have to negotiate price. For example, in America the market for defence equipment is a monopsony, a market in which there are many suppliers and only one buyer. As such, the Department of Defence has strong bargaining power to negotiate the terms of supply contracts;
  3. Brand name strength. A product that has a stronger brand name will be able to be sold for a higher price in the market;
  4. Products differentiation. A firm that produces a product or service that is unique in some way will have more bargaining power and will be able to charge a higher price in the market; and
  5. The availability of substitutes.

[For more information on consulting concepts and frameworks, please download “The Little Blue Consulting Handbook“.]